Published On: Fri, Feb 8th, 2013

Annual Forecast – 2013

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At the beginning of 2012, we argued that the international system is undergoing a generational transformation — the kind that occurs every 20 years or so. The cycle we are now in started in 2008-2009, when global financial contagion exposed the underlying weaknesses of Europe and eventually cracked China’s export-oriented economic model. The Middle East then began to deviate from its post-World War II paradigm with an attempted resurgence by Iran, the regional rise of Islamists and the decline of age-old autocratic regimes in the Arab world.

Generational shifts take time to play out and often begin with a period of denial as the forces of the international system struggle to preserve the old order. In 2013, that state of denial will persist in many areas. But we are more than four years into this cyclical transformation, and change is becoming more palpable and much harder to deny with every passing month.

In Europe, short-term remedies that are so far preserving the integrity of the European Union are also papering over the deep, structural ailments of the bloc. Rising unemployment, growing social discontent, declining competitiveness and the fundamental tension between integration and sovereignty in times of austerity will become more visible, even while the eurozone and European Union survive another year.

China is not so much in denial of its current predicament as it is constrained in its ability to cope with a dramatic shift from high export-oriented growth to more sustainable development of its interior. The shortened timeline for Beijing to make this transition raises the prospect of economic dislocations and social tensions that could place the Communist Party of China in a dangerously reactive position. China still has the tools to manage such flare-ups this year but will compensate for its inadequacies at home and increased U.S. attention to the region with growing assertiveness in its near abroad.

The diffusion of investment away from the Chinese coast will create unique opportunities for a spread of countries in Southeast Asia, East Africa and Latin America, regardless of whether these countries have yet to fully acknowledge the opportunity at hand. The emerging economies of the post-China world will take time to develop, but 2013 will be an important year in determining which are best positioned to fill the growing void left by China.

Change will be primarily violent in nature — and thus harder to miss — in the Middle East. Islamists will carry the momentum in the region but will also struggle to assert power against regional forces trying to preserve the old order. The unraveling of Syria and Lebanon will cut short Iran’s regional ascent and relegate Tehran to the role of a spoiler in the Levant as Tehran turns its attention back to defending its core interests in Iraq.

The United States is also not immune to change. In this generational shift, and all the tumult that comes with it, Washington will be forced to learn the value of restraint in balance-of-power politics, preferring to lean on regional partners and encourage strategic competition as a way of preserving its own power.

The rules of the game are changing in the international system. In 2013, we will see that denial of that change is waning.

Middle East

The Arab world is moving uncomfortably between two eras. The post-World War II era, in which Arab dictatorships and monarchies supplanted colonial rule, is now roughly blending with — or in some cases outright colliding with — a fractured landscape of long-repressed Islamist forces. This transition period will take years, and regional stakeholders, including the United States, Turkey, Russia and France, will struggle to navigate, much less influence, the changing landscape.

The Northern Levant Unravels

This dynamic will be particularly visible in the northern Levant region this year as Syria and Lebanon continue coming apart. From Stratfor’s perspective, the regime in Syria has already fallen and is giving way to a familiar state of warlordism, where militias and clan interests reign supreme. There is no longer a political entity capable of wielding control over the entirety of Syrian territory, nor will there be for some time. Instead, the al Assad clan is the first among equals leading Alawite forces against their Sunni rivals. Sunni rebel forces are for now loosely bound by a common agenda against the al Assad clan. But once Syrian President Bashar al Assad is removed from power, whether through a negotiated deal or by force, the Sunni forces will fragment along ideological, ethnic and geographic lines, with Salafist-jihadist forces battling against a more politically minded Muslim Brotherhood and secular Sunnis. Maronite Christians, Druze, Kurds, Palestinians and other minorities will largely remain in limbo, trying to protect their kin by building militias and flexible alliances in a growing state of lawlessness.

As their grip over Aleppo slips, Alawite forces will try to hold Damascus while preparing a mass retreat to their coastal enclave. The battle for Damascus could extend beyond the scope of this forecast. The Alawite forces face an ever-growing struggle to maintain territorial control beyond the coast. They will eventually shift from conventional to insurgent tactics once it becomes clear that they can no longer hold Damascus and their focus shifts to preventing (with Iran’s help) the consolidation of a post-al Assad government. The United States, Turkey, France and others will attempt to prop up a post-al Assad provisional government and preserve as much of the state machinery as possible to smooth the transition, but the authority of this government will be weak and its sustainability will be questionable as the country continues to fragment.

An unquestionable Alawite loss of control over Damascus will be the trigger for significant sectarian clashes in Lebanon, particularly in the northern borderland, as emboldened Sunnis attempt to challenge their Shiite rivals and as militant group Hezbollah fights to hold its ground. Lebanese clans will prepare for this inevitability by reinforcing their militias and shifting alliances where necessary.

The potential use of chemical weapons by Alawite forces in a state of desperation could accelerate the unraveling of the region; a U.S.-led coalition would have to assemble in haste to contain the chemical weapons threat. To be clear, the United States is not looking for a pretext to intervene militarily in Syria. On the contrary, the United States will make every effort possible to avoid another military campaign in the Islamic world this year.

Iran’s Struggle

A military conflict between the United States and Iran remains unlikely in 2013. Iran can sow instability in places like Syria, Lebanon, Gaza and Afghanistan but lacks the degree of political influence to coerce Washington into a broader strategic negotiation on its terms. The United States is more likely to allow the effects of sanctions and a reversal of Iran’s fortunes in Syria and Lebanon to run their course and continue to weaken Iran’s hand than to agree to significant concessions to temper ongoing tensions with Tehran.

The growing disparity in the U.S. and Iranian negotiating positions will largely relegate Iran to the role of regional spoiler. So long as Iran can create pain for its regional adversaries, it can slow its own descent. Iran will thus expend considerable effort in politically, economically and militarily sustaining its sectarian allies in Syria and Lebanon so it can play a destabilizing role in a growing climate of civil war and insurgency in the northern Levant. Iran will also use weapons transfers as its primary means of maintaining a stake in the Palestinian Territories.

Iraq remains Iran’s primary regional imperative, however. The momentum building among Sunni forces in Syria will eventually spill into Iraq and challenge Shiite dominance. This trend will take time to play out, but in preparing for the eventuality, Iran will reinforce its Iraqi Shiite allies while exploiting growing divisions among the Kurds in an attempt to hold its position in Iraq against Sunni and Turkish resistance. Growing tensions between the Iraqi Shiite government and the Kurds, as well as the Sunnis, will facilitate Tehran’s efforts to influence the government in Baghdad as the Shiites in Iraq become more isolated and thus dependent on outside support. Maintaining leverage in Iraq, an important conduit for Iranian smuggling, will also prove crucial in Iran’s efforts to withstand tightening sanctions this year.

Iran’s financial resources are being drained under the U.S.-led sanctions regime, but powerful state control over the economy and Iran’s regular exploitation of sanctions loopholes in league with willing business partners will buffer the regime against systemic collapse. The political influence of Iran’s Islamic Revolutionary Guard Corps, which is just as crucial to the regime’s sanctions-busting and militant proxy-management abroad as it is in preventing unrest at home, will grow this year. Iran’s presidential elections in June will reveal the declining relevancy of the clerical elite and the populist faction embodied by outgoing President Mahmoud Ahmadinejad. This creates a political void for the Revolutionary Guard to fill. The Supreme Leader Ayatollah Ali Khamenei will try to check the Corps’ growing influence by bolstering rival military and security agencies and backing a less controversial and more politically malleable ally from the pragmatic conservative camp for the presidency.

The Arab World in Transition

In Egypt, the military will adapt to an emerging Islamist political order. The military will remain the ultimate arbiter of the state and will rely on a number of factors — including a fragmented judiciary, the military’s economic leverage, a divided Islamist political landscape and the military’s foreign relationships — to check the Muslim Brotherhood. But the military and the Brotherhood will not be capable of engaging in bold, unilateral moves against one another. They need each other in this new political environment, and so both sides will continue trying to set boundaries and ultimately develop a new working agreement. There will be obstacles and occasional political crises as a result, but this year will not see a break between the Muslim Brotherhood and the military.

The Brotherhood will be able to maintain a large presence in parliament, but will face resistance from elements of the old order in asserting control over state institutions. The Brotherhood’s popularity among the people will be undermined as the movement takes on a larger role in governance under severe economic conditions; the foreign aid that the state increasingly will depend upon will be contingent on the state’s implementing unpopular and potentially destabilizing austerity measures.

Egypt’s consuming political transition will leave opportunities for flare-ups in the Sinai Peninsula and in Gaza, but we do not expect a significant breach between Israel and Egypt this year. After having demonstrated its militant capabilities in late 2012, Hamas will focus on building up its political legitimacy in the region in 2013 at the expense of its secular rivals in Fatah. Hamas’ efforts will entail reining in potential rivals within Gaza that could upset the group’s political trajectory and trying to expand influence in the West Bank.

Jordan, the oft-overlooked casualty of the Arab Spring, will continue to destabilize quietly and slowly in 2013. The Hashemite monarchy will see its room for political maneuvering narrow as it faces an emboldened opposition led by the Jordanian Muslim Brotherhood and strengthened by tribal elements and urbanite Palestinian-Jordanians. Limited support from the Gulf Arab monarchies will add to the economic and energy pressures exacerbating the Hashemites’ political vulnerabilities.

The Reactive Powers

Israel and Turkey are both greatly affected by the shifting political dynamics of the Arab world, but both have little means to influence the change. The two former allies will continue exploring ways to restore a quiet working relationship under these new regional stresses, but a public restoration of diplomatic ties is less likely.

Israel will struggle internally over how to adapt to a new regional framework in which the reliability of old working partners is called into question. In contrast, Turkey sees an opportunity in the rise of Islamist forces in the Arab world but Ankara’s limited influences restrain its actions beyond Turkish borders. Moreover, the vulnerabilities arising from a power vacuum in Syria will undermine Turkish attempts to enlarge its sphere of influence. As Syrian Kurds work toward some degree of autonomy in the north, Iraqi Kurds will use that as leverage in their dealings with Ankara. Iran’s efforts to reverse Turkish influence in Iraq and Syria through Kurdish antagonism will also greatly complicate Ankara’s already troubled containment strategy against Kurdish separatism. The growing regional Kurdish threat to Turkey, not to mention a slowing economy, will factor into domestic political skirmishing ahead of the 2014 election season, but the Turkish opposition will still lack the ability to significantly undermine the ruling party’s popularity at home.

Unease in the Arabian Peninsula

Saudi Arabia also faces limited options in shaping a post-al Assad Syria. The Saudi royals are pleased to see Iranian influence on the decline in the Levant but are wary of Iranian backlash closer to home. Saudi Arabia is also greatly concerned by the regional rise of the Muslim Brotherhood and will try to counteract this trend by supporting Salafist-jihadists in Syria and Lebanon. A more aggressive Saudi role in Syria will aggravate the civil war and create competition with other regional stakeholders, including Turkey, Qatar and Jordan.

At age 88, Saudi King Abdullah’s deteriorating health and probable death will mark the end of the second generation of Saudi princes. Crown Prince Salman bin Abdulaziz will succeed Abdullah, and the odds are high that Salman’s successor will come from the third generation of princes, who will have increasing say in the affairs of the state. In the Saudi periphery, Bahrain will keep Shiite unrest at a manageable level by engaging the mainstream Shiite movement, Al Wefaq. In the southern heel of the peninsula, the Yemeni government’s attempt to restructure the military and security forces to manage an ongoing power struggle likely will lead to more instability in the country.

Trouble in the Maghreb

While weak governments in Libya and Tunisia continue struggling to institutionalize power along the Mediterranean coastline, the lower Maghreb and Sahel regions are at risk of destabilizing further as regional al Qaeda forces emanating from Mali prepare for a Western-backed intervention. Libya, Tunisia and Egypt remain locked in internal turmoil while Algeria, having already gone through a civil war in its recent history and endowed with substantial energy resources, is emerging as the regional leader of the Maghreb. Key to Algeria’s continued stability is its ability to maintain a carefully crafted containment strategy against Islamist militants. This strategy is at risk of unraveling as Western forces attempt to pursue and displace local jihadist forces. Algeria will try to shape international involvement in Mali according to its own terms and attempt to use its security capabilities and energy relationship with the West to gain recognition of its rising regional status and accommodation of its security needs.

Europe

In 2012, the European Union took numerous steps to mitigate the financial impact of its ongoing crisis. One of those steps was the creation of the European Stability Mechanism, a permanent rescue fund for members in need. Another important measure was granting the European Central Bank more power to intervene in the bond markets to assist countries in distress. These actions, which helped to keep the eurozone afloat in 2012, will remain effective in 2013, making it very likely that the eurozone will survive another year. But these tools do not solve three fundamental aspects of the European crisis.

First, the European crisis is fundamentally a crisis of competitiveness. The economies of the eurozone’s south, which were seen as creditworthy before the crisis, are not as dynamic and competitive as the economies of the north and manufacturing bases that emerged in Asia over the past decade. In the past, the peripheral economies could implement monetary policy to address their lack of competitiveness, but that option is not available since the introduction of the euro. As a result, the only alternative for these peripheral economies is fiscal policy — which over the past few years has taken the form of painful austerity measures and wage suppression.

Second, the crisis has a political aspect. The European Union is not a federation but a collection of nation-states bound together by international treaties. This means that decision-making in the European Union is always a delicate balance between integration and sovereignty. All the policies emanating from Brussels to mitigate the effects of the crisis involve the transfer of sovereignty to a supranational entity — either to provide financial assistance to countries in distress or to put national budgets under the supervision of supranational institutions. Because of their supranational nature, these policies often generate political tensions between countries (as they seek to protect their national interests) and within countries (within national governments or among the population).

Third, the European crisis is threatening the social stability in some countries, especially in the eurozone’s periphery. The austerity measures that Brussels has requested are generating growing social discontent that threatens the longstanding hold on power of the traditional political parties and that strengthens extremist parties on the left and the right.

This triple dimension of the European crisis, which intensified in 2012, will influence the coming year.

The Crisis Reaches the Core

In 2012, the economies of the northern eurozone (especially Germany, France, the Netherlands, Austria and Finland) were less affected by the crisis than were their southern neighbors. They experienced relatively low levels of unemployment and some of them saw modest growth. In this regard, the economic crisis was largely focused on the eurozone periphery. In 2013, the two largest economies of the eurozone (Germany and France) will face low growth or even stagnation. This will have negative effects across Europe.

Paris will react to the crisis by designing structural reforms in an effort to improve the competitiveness of the French economy and to boost economic activity. These measures, which will include labor market reforms, will not please the French unions. The discontent of the unions and the slowdown in the French economy in 2013 will lead to the largest protests in France since the beginning of the crisis.

Economic stagnation in Germany is unlikely to lead to radical changes in domestic policy, since the slowdown will be gradual and unemployment will rise slowly from a relatively low level. Moreover, the parliamentary elections — which are expected in September or October — will slow the decision-making process in Germany substantially, so no fundamental changes in foreign policy will be made before the elections.

The German elections will in turn slow the decision-making process at the European level. The EU leaders will likely discuss several institutional reforms — including a modification of the EU treaties and crucial policies such as the creation of eurobonds — but there will be no substantial institutional reforms in 2013. Agreements on other smaller issues, such as the technical aspects of the banking union and reforms of the EU budget, are likely in 2013.

At the same time, the economic slowdown in Northern Europe will make these countries more reluctant to provide financial aid to the periphery. But we expect the European Union to continue assisting the troubled economies as needed.

Worsening Economic Conditions in the Eurozone Periphery

In 2013, the crisis will keep damaging economic conditions in the eurozone periphery. Greece, Spain, Portugal and Italy will see their economies shrink and unemployment rates rise. In all these countries, the social unrest will grow and the year will be marked by permanent protests and strikes.

The conspicuous divide between the ruling elite and the populations of the periphery will be a key element in 2013, and some governments could fall. But even if opposition parties take power, they will face the same constraints as the governments that preceded them. In other words, a change in politicians will not bring a substantial change in policies regarding the European Union. Largely, these countries will still be applying austerity measures next year, although we do expect these countries to be more vocal in their requests for concessions from their lenders. Under the threat of an escalation of the crisis, the European institutions are likely to make such concessions.

Although extremist or anti-establishment parties will gain influence over the political debate, they will not be strong enough to take power in any eurozone country. Each electoral cycle weakens popular support for mainstream parties in Europe, but the traditional elites will manage to stay in charge in 2013.

Political and social instability will be particularly acute in Greece, but the country will manage to remain in the eurozone in 2013. The Greek government will continue to receive European financial assistance in 2013 — something that will prevent the country from leaving the eurozone. Moreover, Athens is likely to receive concessions from the European Union (likely a renegotiation or softening of the country’s fiscal and economic targets) if necessary. During 2013, Spain will probably need further financial assistance from the European Union; Stratfor expects Madrid to reach an agreement with its lenders, since Brussels is interested in containing the effects of the Spanish economic crisis and preventing it from spreading to the rest of the eurozone.

The only country in the eurozone periphery that has scheduled elections is Italy (in February). If the next Italian government fails to achieve political stability and apply economic reforms, the increased market pressure on Italy will make Rome more likely to require financial assistance from Brussels. If that happens, Italy and the European Union are very likely to reach an agreement.

Increasing Political Fragmentation

Because of the fundamental contradictions in the national interests and foreign policy strategies of the EU member states, the European crisis will continue generating political and economic divisions in the Continent in 2013.

In addition to the existing differences between eurozone and non-eurozone countries, political fragmentation will take place within the eurozone. France will be more vocal in its demands for greater economic solidarity in Europe through eurobonds or analog mechanisms — something that will generate tensions with Germany. During an election year, Paris and Berlin are unlikely to reach an agreement on these issues.

Outside the eurozone, the United Kingdom will seek to protect its sovereignty and renegotiate its status within the European Union. But London will not leave the European Union in 2013. As eurozone countries increase their collaboration to overcome the structural deficiencies in the monetary union, Eastern and Central European countries outside the eurozone will balance their desire for a stronger participation in the decision-making with the advantages of not being a part of the common currency.

During 2013, Europe will enjoy the benefits of the tools that were created in 2012, and the integrity of the European Union will be preserved. But Europe will also suffer the consequences of the deeper political and social aspects of the crisis that have not been addressed.

Former Soviet Union

Domestic Issues

After the political tumult of 2012, Russia will face another year of anti-Kremlin protests, tensions among various political factions and ethnic groups, crackdowns and government reshuffles. Overall, the political tensions will remain manageable and will not pose a serious challenge to Moscow’s control. An invigorated Kremlin focused on rooting out corruption this year will attempt to purge the more dysfunctional and financially costly parts of the government and state firms. Crackdowns on state officials and businesses could look similar to the state’s purges of non-state businesses and oligarchs in the early 2000s.

Measuring Progress in Russia’s Near Abroad

Russia has made significant progress recently in re-establishing influence in its former Soviet periphery. Since staking out its position as a regional power in the Russo-Georgian War of 2008, Moscow has helped unseat the governments in Ukraine, Georgia and Kyrgyzstan that were swept into power in the wave of color revolutions. Russia has also integrated more deeply with Belarus and Kazakhstan through the formation of a Customs Union, an institution that Russia will continue building up in scope and membership until the bloc becomes the Eurasian Union in 2015.

But Russia’s rise has not been uniform across the entire post-Soviet space. Russia must contend with the domestic political dynamics unique to each state and with foreign powers competing with Moscow’s position in each country. Thus, in 2013 Russia will continue building momentum in some areas of its periphery while its position will face more challenges in others.

As the states most integrated into the West, the Baltic countries will continue their efforts at energy diversification from Russia in 2013 and increase economic and security cooperation with the European Union and NATO in general and with the Nordic countries in particular.

Russia’s relationship with Ukraine could be its most important connection in the former Soviet Union in 2013. Russia has been pursuing integration with Ukraine, primarily by taking over its natural gas transit infrastructure and calling on Kiev to join the Customs Union. Ukraine was able to resist Russia’s efforts in 2012 by substantially lowering its imports of Russian natural gas. But this cut was enabled largely by storage supplies and a warm winter rather than by any serious progress on energy diversification (such as in Poland and the Baltics) or closer integration with the European Union. Therefore some sort of compromise between Russia and Ukraine over these issues is likely in 2013.

Georgia will be Russia’s main concern in the Caucasus in 2013. With the political emergence of billionaire tycoon Bidzina Ivanishvili and his Georgian Dream movement, Russia’s position in the country strengthened at the expense of the anti-Russian camp of Georgian President Mikhail Saakashvili. The October presidential election and accompanying constitutional change will give Ivanishvili the opportunity to consolidate power this year. While major foreign policy shifts away from the West and NATO or complete normalization with Russia are unlikely for Georgia in 2013, this new political reality could create tensions with regional players who are nervous about further Russian encroachment, particularly Azerbaijan.

Kyrgyzstan and Tajikistan will pursue closer economic and security cooperation with Russia and will move forward with their plans to join the Customs Union by 2014. Uzbekistan will continue resisting Russia’s integration efforts, though it will not make any meaningful progress toward greater security collaboration with the West or China.

Russia and the West

In the past year, Russia has changed its tactics toward Europe to preserve its presence and leverage for the future. Russia’s primary link to Europe is the Europeans’ dependence on Russia’s large energy supplies, which Moscow knows will be threatened when more non-Russian supplies become available. In 2012, Russia began shifting away from its aggressive stance on energy — particularly its high prices — to strike long-term deals that will maintain Russia’s market share with its primary strategic customers, such as Germany, Italy and Turkey. Russia will continue this strategy in 2013 as it continues to build new infrastructure to directly link its supplies to Europe. Russia will also attempt to lessen its dependence on the European market by launching major energy projects in East Siberia meant to provide more supplies to Asian markets in the future.

Russia’s ultimate goal in Europe is to use its energy relationships to build strategic partnerships — particularly with Germany — in order to influence the region. However, Russia’s efforts toward this end will be limited in 2013; first, Russia is still trying to ensure its energy and security influence in Europe, and second, Germany is preoccupied with more immediate domestic issues.

As Russia tries to manage its relationships with its major energy customers in Europe, it likely will avoid aggressive behavior on other issues, including its reaction to U.S. plans for ballistic missile defense in Europe this year. The United States and Russia will continue sparring over trade matters, negotiations for a new nuclear arms treaty and Russia’s role in Iran and Syria. Stratfor does not expect major changes from Washington or Moscow that would break the gridlock in negotiations on these issues.

Central Asian Security

The low-level violence and instability that occurred throughout Central Asia in 2012 will continue in 2013. Much of the violence and militancy in the region will continue to be politically motivated, particularly in Kazakhstan, where the question of who will succeed long-serving President Nursultan Nazarbayev looms. Uzbekistan and Kyrgyzstan will continue encountering threats to their stability, such as protests, violence and cross-border skirmishes. Tajikistan will be especially at risk because it will hold its presidential election in November, and the volatile political environment there could reopen the rifts that were underlying elements of Tajikistan’s civil war in the 1990s.

Pre-existing regional tensions among these countries (which are centered around the restive Fergana Valley) could lead any unrest to spill across the countries’ borders. Moreover, the anticipation of the U.S./NATO withdrawal from Afghanistan in 2014 will create additional problems in Central Asia’s security environment.

East Asia

Three things will shape events in East Asia in 2013: Beijing’s struggle to maintain social and political stability amid lower economic growth rates; China’s accelerating military modernization and increasingly aggressive moves to secure its territorial and economic interests in the region; and varied efforts by other regional players, including the United States, to adapt to China’s changes.

In 2013, the Chinese economy will continue the gradual, painful process of moving away from high export-driven growth and toward a model that is more sustainable in the long run. Export growth will not pick up substantially, weighed down in part by continued economic malaise in Europe. The effects of rising wages and input costs in China’s traditional coastal export-oriented manufacturing powerhouses on overall Chinese competitiveness relative to emerging regional economies like Indonesia, the Philippines and Vietnam will also hamper export growth.

But barring another global financial meltdown on the scale of 2008-2009, China’s coastal manufacturing economy will not collapse outright. The decline will be gradual. In 2013, more factories — particularly low-end manufacturers with the thinnest profit margins — will move overseas. Many others, drawn to China’s superior transport and supply chain infrastructure, as well as its growing consumer market, will stay put or move inland, where labor is abundant and wages are lower. The ongoing, gradual eclipse of coastal China as a hub of global manufacturing over the next several years will lead to higher unemployment and social dislocation as more of China’s 250 million-strong migrant labor force returns inland in search of work.

Beijing therefore will continue to balance conflicting domestic needs in 2013. It must maintain high levels of industrial activity and employment, especially as more coastal factories lay off workers or close entirely. But the Communist Party cannot afford the potentially destabilizing effects — from high inflation to a bursting of the property bubble — of another round of stimulus such as that seen in 2009-2011. Overall employment will be sustained through a combination of investment into large-scale infrastructure projects (especially transport and urban infrastructure development in inland provinces) and cycles of targeted, temporary loosening of controls on the real estate market. Beijing will continue economic rebalancing in the broad sense by encouraging greater economic activity in interior China, and especially in provinces lining the Yangtze River and in those bordering coastal provinces.

In an effort to accelerate inland urbanization, the government may introduce limited reforms to the hukou, or household registration, system. But the continued premium on employment will constrain any effort to genuinely restructure the economy toward greater efficiency, productivity and profitability. Government-led investment and debt will continue to underpin China’s economy in 2013.

As the Chinese export economy sputters and the government attempts to redirect investment away from property and toward more sustainable projects, it will have to guard against potential threats to its financial system, especially by the increasingly important shadow-lending sector. Shadow banking is by no means new in China. But it has grown significantly in the past few years from the geographically isolated informal loan markets of coastal cities to a complex network of semi-legal entities that provides between 12 and 30 trillion yuan (between $1.9 trillion and $4.8 trillion) in credit — at interest rates of 20-36 percent — to thousands of struggling small businesses nationwide.

Shadow lending is not inherently problematic. In fact, it is necessary in an economy where official financing is often limited to well-connected state-owned enterprises. But export growth is slowing and unlimited stimulus spending (much of which has gone toward construction, driving China’s skyrocketing demand for steel, cement, coal and other materials between 2009 and 2011) is at an end. This means that more and more recipients of shadow loans are likely to default. Beijing is quite capable of offsetting the short-term financial consequences if a shadow-banking crisis occurs in 2013. However, the residual effects — from inflation to unemployment to protests by shadow-banking products investors (including millions of ordinary Chinese citizens) — could significantly challenge social and political stability.

The Party’s Tasks

In 2013, the Communist Party of China will have to manage tremendous social and economic change even as it completes its own generational leadership transition and works to rebuild and reform the Party’s image, if not its actual practices. The political scandals of 2012 greatly harmed the Party’s public image, but the system survived. The generational transfer of power may give the Party a chance to reconsolidate its ranks and its control over China’s vast domestic security, censorship and military apparatuses, but the Party is not yet on safe ground. The Party’s growing sense of insecurity — both internally and with regard to the social consequences of China’s economic transition — likely will be reflected in continued censorship of online social platforms like Weibo, crackdowns on religious or other groups perceived as threatening, and the Chinese military’s growing assertiveness over China’s interests in the South and East China seas and Southeast Asia.

Regional Effects of China’s Changes

The ripple effects of China’s slow transition away from its two-decade reign as the world’s key supplier of low-cost goods will be felt more strongly throughout East Asia in 2013, but they will not be felt uniformly. The decline of low-end coastal manufacturing in China will present enormous opportunities for Southeast Asian countries like Indonesia, Vietnam, the Philippines and potentially Myanmar — all of whom will continue to push strongly for foreign investment not only into natural resources and raw materials industries but also into developing better urban, transport, power generation and materials processing infrastructure. At the same time, China’s readjustment to lower overall growth rates will pose near-term challenges, as Chinese consumption of raw materials — on which much of Southeast Asia has come to depend — stabilizes from the unsustainable highs of 2010-2011. More developed economies such as South Korea, Singapore and Australia, which also rely heavily on Chinese demand but are less well positioned to benefit from the diffusion of foreign investment away from coastal China, will be increasingly hard-pressed to maintain growth and employment.

Even as the region repositions itself in relation to China’s economic transition — and any resulting regional or global economic instability — Beijing’s growing military capabilities and assertiveness will pressure other East Asian countries. In Northeast Asia, China’s military modernization will add fuel to Japan’s military normalization process, including renewed efforts to lift constitutional limitations on the use of Japan’s armed forces. It could also accelerate the transfer of Japanese business and investment toward emerging Southeast Asian partners as diplomatic tensions and territorial disputes threaten Japanese manufacturing and business interests in China. The Korean peninsula, caught between Chinese military modernization and possible Japanese normalization, may push for greater rapprochement, especially as the North attempts to reduce gradually its dependence on Chinese support.

Meanwhile, Vietnam and the Philippines — China’s most vocal opponents in Southeast Asia — will continue to push for greater integration among members of the Association of Southeast Asian Nations and for U.S. business and military engagement in the region. 2013 will be a critical year for Myanmar as it works to solidify its democratic opening — and in turn to reduce its strong dependence on Chinese investment. Beijing, recognizing the threat greater Western investment and influence in Myanmar pose to its own strategic and energy interests in Southeast Asia and the Indian Ocean basin, could undermine Myanmar’s opening — either through increased economic support or by stirring ethnic tensions along the China-Myanmar border. What happens in Myanmar in 2013 will in turn shape the Association of Southeast Asian Nations’ political and economic development going forward as well as the potential for deeper ties between the United States and the Association of Southeast Asian Nations.

South Asia

The Coming U.S. Withdrawal from Afghanistan

Ahead of the 2014 drawdown of U.S. troops from Afghanistan, efforts will intensify to negotiate a settlement that gives the Taliban a place in a new government. The Taliban could make organizational shifts to highlight their political role. Depending on progress made in the negotiations, the organization could establish a formal political arm to represent the Taliban’s Mullah Omar-led leadership in future power-sharing talks. The United States could offer some acknowledgement of the Taliban’s political status and exploit the Taliban’s increased interest in foreign investment to extract guarantees from the group on neutralizing transnational jihadist activity. At the same time, the United States will focus heavily on trying to find successors to Afghan President Hamid Karzai to keep a check on Taliban power.

The negotiations will face numerous obstacles this year. There will be an upsurge in violence — both in terms of officially sanctioned attacks designed to gain advantage on the negotiating table and spoiler attacks by Taliban elements allied with al Qaeda on both sides of the Afghan-Pakistani border. Moreover, Pakistan faces a politically distracting year. Parliamentary polls are scheduled for 2013, marking the first time that a duly elected democratic government will have completed its term and transferred power to a new civilian government without interference. By the end of the year, the military leadership will also be reshuffled. The balance of power within the civilian and military forces likely will be maintained in this transition and thus no major divergences in domestic or foreign policy are expected. The emerging military leadership is already engaged with the United States in the negotiations for a settlement in Afghanistan. But the complexity of the talks and the political sensitivities surrounding the election period will give Islamabad a rationale for holding out on the more contentious points of the negotiations, especially as Pakistan struggles to manage domestic militant backlash against the negotiations.

Washington’s intention to reduce its presence in the region will spur regional actors to fill the void. Pakistan will increase its interactions with Russia, Central Asia and Iran to prepare for a post-U.S. Afghanistan. India, sharing regional concerns about Islamist militancy spreading from Afghanistan, will also be more engaged with these regional stakeholders to preserve its still-limited economic and diplomatic presence in the region and buttress itself against the inevitable rise in instability emanating from southwest Asia. India and Pakistan will remain wary of each other’s intentions but will use a slow-moving normalization process to stay abreast of each other’s plans for Afghanistan and prevent tensions from erupting.

India’s Balancing Act

India will also turn its attention eastward, where the United States is quietly trying to forge a coalition of regional partners to keep a check on China in the Indo-Pacific basin. Myanmar in particular will be an active battleground for influence this year. India will avoid formal alignments but will find common cause with Japan, Australia and Southeast Asian nations that will allow Japan to expand its economic, political and security relations in the area. India does not want a confrontation with China, nor is it looking to tie itself to U.S. foreign policy in the region when it comes to issues like China or Iran. As with Pakistan, India will expend some energy on the diplomatic front to normalize its relationship with Beijing and help mitigate any tensions that arise from this underlying regional competition.

Among the Indian people, the country’s economic slowdown and increasing energy needs are a higher priority than its foreign policy concerns. As the opposition tries to unite under a new leadership ahead of 2014 elections, it will be battling with the ruling minority United Progressive Alliance government at the regional level in preparation for the polls.

Latin America

Preparing for a Post-Chavez Venezuela

After a year of successful campaigning for re-election, Venezuelan President Hugo Chavez is in questionable health. Although the ultimate outcome of December’s medical treatment for the ailing leader is unpredictable, Chavez’s decision to name Vice President Nicolas Maduro as a political successor at the end of 2012 indicates that there is significant concern for his ability to remain in power. Chavez generated a great deal of momentum through his Oct. 7 electoral victory and garnered favorable emotions as a result of his relapse. If Chavez steps down or is incapacitated, the Venezuelan Constitution mandates elections within 30 days. If Chavez turns power over willingly, he stands a chance of being able to rule behind the scenes in support of Maduro, facilitating a political transition model very similar to that of the Castro brothers in Cuba.

Although it remains possible that Chavez will stay in power through the year, for Maduro to capitalize on Chavez’s recent political gains, elections may need to be called sooner rather than later, regardless of Chavez’s immediate health status. Thus, Venezuela probably will hold another round of presidential elections in 2013. Although at a disadvantage, the opposition has once again coalesced around Miranda State Gov. Henrique Capriles Radonski. If Maduro wins, he faces an enormous challenge in consolidating control over the state and will have to focus particularly on the pillars of the country — the military, with which National Assembly leader Diosdado Cabello has influence, and the energy sector, which is managed largely by Energy Minister Rafael Ramirez.

Venezuela’s biggest challenge concerns the economy. Although inflation was manageable through 2012, the bolivar is under growing pressure and the government will have to consider another devaluation of its currency and cuts in public spending. If Caracas fails to devalue or significantly reduce social spending, the government will have difficulty financing its obligations.

The possibility of elections in 2013 will complicate the decision-making process for political leaders. Although social spending fell after October elections, a new vote would require additional spending that would pull from development and rainy-day funds and directly from the national oil company, Petroleos de Venezuela. This reliance on Petroleos de Venezuela will further strain the already overburdened company, and related challenges will generate social instability throughout the year. Overall, there is a high likelihood of economic deterioration, but the government will be able to manage these challenges.

Peace Talks with Colombia’s Rebels

Throughout 2013, Colombia will continue the incremental process of negotiating an end to the conflict with the Revolutionary Armed Forces of Colombia, known by its Spanish acronym FARC. With presidential and parliamentary elections scheduled for the first half of 2014, the government would almost certainly like to have a positive conclusion to the negotiations by the stated deadline of November 2013, and it stands a good chance of achieving that goal.

In the meantime, the government has made clear its intent to continue pursuing its military campaign against the FARC and a host of organized criminal groups. A unilateral cease-fire on the part of the FARC is set to expire in February, and its renewal will depend on the status of the negotiations. The group could resume militant attacks on government-run energy infrastructure as a way to raise the stakes of the negotiations and prove its operational command. Outside the scope of the negotiations, significant violence and criminality generated by other criminal and militant groups will continue throughout Colombia. At the same time, the government can be expected to continue efforts to improve infrastructure and attract foreign investment, particularly into minerals extraction.

Mexican Regime Change

This will be a year of significant transition for Mexico. Policy issues that were bottled up by intra-party competition in the waning years of the National Action Party’s administration have begun coming to the fore and will dominate 2013. These include socio-political issues like education, tax and pension reform. Many of these reforms can be expected to generate significant controversy and scattered unrest, and implementing the changes made in the first months of President Enrique Pena Nieto’s administration will take years.

The most important issue facing Mexico in 2013 will be energy policy. Over the course of the year, details about Mexico’s plans for encouraging additional investment in the energy sector that is needed to revive flagging production will emerge. If a final decision is made in 2013, it will be toward the end of the year, since significant negotiations within the ruling party and between the ruling party and competing political parties will need to be accomplished. There is sufficient support for the governing Institutional Revolutionary Party at the state level to permit Pena Nieto to seriously consider the possibility of constitutional reform that would allow the country to adopt production-sharing agreements, which are standard throughout global energy extraction markets but are illegal in Mexico.

Meanwhile, the government will continue fighting cartels using the military. The Pena Nieto administration has made it clear that the Mexican government will make organizational changes, including the strengthening of federal control over state law enforcement agencies and the creation of a gendarmerie designed to combine the strengths of law enforcement and the military.

But in the short term, there are few options for altering course or meaningfully changing the nature of the fight, which is defined first by competition among the criminal groups. There are no signs yet that some sort of truce among these groups will be possible in the coming year, and violence can be expected to continue much as it has in the past several years — on a shifting geographical basis as each group competes for supply chain and market access at the expense of the others. Any government attempts to mediate a truce will be held in the strictest confidence to avoid a public backlash.

Trade Bloc Expands

The Common Market of the South, or Mercosur, is set to expand to include Bolivia and Ecuador in 2013 in a process that will consolidate the left-leaning countries of Latin America under a single economic and political umbrella dominated by Brazil. The expansion will strengthen Brazil’s long-term ability to expand its influence in the region and will solidify an ideological split in the region.

Paraguay’s readmittance to Mercosur as a voting political member will play a key role in the timing of Mercosur’s expansion. If Paraguay’s April elections are deemed sufficiently democratic by regional multilateral observers, Paraguay will be readmitted to the bloc. Because Paraguay has made no secret of its opposition to the bloc’s expansion, parliamentary approval of Mercosur’s enlargement will have to occur in Venezuela, Argentina, Brazil and Uruguay before Paraguay rejoins the bloc.

Throughout 2013, Brazil will continue its attempts to use government-led reform to adjust to market challenges with mixed success. A significant push in 2012 to increase investment in and improvement of major infrastructure — including roads, airports and maritime ports — will begin to be realized in 2013 but will be slowed by bureaucratic processes. Although government spending probably will support growth, it could increase inflation. Despite government adjustments to a range of regulations in an effort to effectively respond to demands from manufacturers, there is political opposition to the strong involvement of the state in economic management. Nevertheless, Brazilian President Dilma Rousseff remains highly popular, as does her administration. With the presidential election approaching in 2014, the political opposition led by the Brazilian Social Democracy Party will attempt to erode that popularity over the course of the year. Absent a major external shock, however, this will be a gradual process.

Just such a potential external shock lies to Brazil’s south, in Argentina. While likely to maintain its current social and economic system running in 2013, Argentina will see increasing uncertainty. Preparations for October legislative elections and efforts to manage the energy sector will dominate Argentina’s political landscape. Because of the presidential administration’s pursuit of a pro-government outcome in the legislative elections, there will be a great deal of tension between the central and regional governments. For President Cristina Fernandez de Kirchner, a majority of support in the legislature will raise the possibility of constitutional reforms, including changes to allow her re-election for a third term. In the energy sector, Argentina will continue pressuring potential investors, including U.S. energy giant Chevron, to invest heavily in Argentina’s promising geological deposits with some — but limited — success. The government will also attempt to use state resources to manage growing failures in electricity infrastructure.

The year will be characterized by social unrest and political friction. Strong trade controls that helped Argentina manage its delicate trade balance will continue in one form or another as the government uses the controls to secure its hold on foreign exchange. The impact of these trade controls will require careful negotiations with Brazil throughout the year.

Sub-Saharan Africa

Southern Africa

The consolidation of Zulu political power in South Africa with the re-election of Jacob Zuma as African National Congress president in late 2012 will enable South Africa to take a more assertive role in the region this year. South Africa will use its state-owned enterprises to expand and deepen its political influence on the continent. This will include port, rail, airline and power production investments to tie developing southern African economies into the South African hub of economic activity. Expanding road, rail and port capacity will facilitate the movement of goods and services into African markets and the movement of mineral commodities from southern Africa to international markets. This will become more important as economies neighboring South Africa develop and their natural resources receive economic interest from outsiders, including China, India and Europe.

Mozambique will aim to finalize plans with investors from the United States, Europe and Asia to commit to developing its liquefied natural gas and coal sectors. Maputo will also work on building out its road, rail, port and power infrastructure for two purposes: first, to secure the foreign investments in natural gas and coal, and second, to allow the ruling Liberation Front of Mozambique to secure political control in opposition-friendly provinces ahead of 2014 national elections.

South Africa will support Maputo with technical and economic investments to help develop Mozambique’s infrastructure, including natural gas-fired power plants in Mozambique and South Africa to develop Mozambique’s natural gas industry. These efforts will reinforce Pretoria’s ties with Maputo and Maputo’s control over the remote central and northern parts of Mozambique, where it wants to secure political control and deny opposition parties any increase in support.

Zimbabwe will see pending investment interest for its agricultural and extensive mineral commodities potential. But 2013 will not bring a liberalization of the Zimbabwean political economy, which will hamper the investment that Harare attracts. The ruling Zimbabwe African National Union-Patriotic Front could hold elections in mid-2013 that could bring about significant intimidation of Zimbabwean citizens and the opposition Movement for Democratic Change. As a result, the government led by President Robert Mugabe will retain its status as something of a pariah. South Africa will mediate in Harare to try to facilitate a transition to a government more cooperative with Pretoria, but these efforts will face successful resistance until Mugabe no longer leads Zimbabwe.

East Africa

Incremental progress will be made during 2013 toward regional integration in eastern Africa, with the ultimate aim of achieving integrated road, rail and port infrastructure and combining the region’s markets into an economy able to sustain growth and foreign investment. The countries of the sub-region, led by Kenya, Tanzania and Uganda, will work toward developing a monetary union, reducing trade barriers and developing common infrastructure projects, though materializing these projects, as well as those involving the region’s natural gas and crude oil sectors, will extend beyond the year.

Kenya’s attempt to entrench its position as the region’s commercial hub through economic development and regional cooperation will be disrupted briefly in early 2013. National elections in March will trigger a short period of inter-ethnic violence that will paralyze the country. The East African region and the international community will pressure the Kenyan political elite to agree to another coalition government that shares power and patronage in order to keep the intense civil conflict brief. Once the elections are completed, Nairobi will resume efforts to secure backing for its regional infrastructure plans, especially rehabilitating road and rail networks to Ethiopia, South Sudan and Great Lakes region countries and expanding its ports at Mombasa and Lamu.

West Africa

Nigeria will face a year of mounting insecurity that will carry into 2014. Political party leadership elections in late 2014 will force regional and political groupings throughout the country to mount campaigns using armed groups and violence. Islamist militant group Boko Haram will sustain a high tempo of attacks against civilian and Nigerian government targets in northeastern Nigeria and try to expand to the country’s northwestern region. However, its sphere of attacks will not spread into southern Nigeria, threatening the commercial capital of Lagos or the Niger Delta oil-producing region.

Niger Delta political elites, including President Goodluck Jonathan, will consolidate an elections campaign that will result in activities that destabilize the energy sector. Niger Delta groups will increasingly kidnap workers — for ransom and also to demonstrate their ability to disrupt economic activity — and will tamper with the region’s oil pipelines to steal, or “bunker,” crude oil.

Another consequence of the Jonathan campaign will be that no disruptions of policy and governance programs will occur. For example, economic reforms that the administration has proposed, such as the Petroleum Industry Bill aimed to introduce market reforms into the energy sector, will not be passed because Jonathan will need to avoid generating political opposition and prematurely damaging his chances at re-election. The lack of reform consequently will dampen new investment in new oil and natural gas developments, though existing offshore fields — more immune than onshore fields to political strife and militant insecurity — will still be developed.

Mali will attract ongoing security interest from the West, motivated by the desire to deny al Qaeda in the Islamic Maghreb sanctuary in the country. The Malian army and neighboring African governments will lead a Western-backed military intervention force that works to recover government control, with the African neighbors supporting the effort in order to prevent al Qaeda in the Islamic Maghreb from expanding its reach. The military intervention will occur incrementally as a result of strategic constraints and conflicting interests with Algeria, an emerging regional power. The intervention could begin during the third quarter of 2013, after several months of diplomacy and training to signal to neighbors and stakeholders that the strategy has comprehensive safeguards.

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